United States
Hong KongRollovers: direct, indirect, and the twenty per cent trap
A direct rollover moves funds trustee to trustee with no withholding. An indirect rollover pays the participant, triggers mandatory 20 per cent withholding from an employer plan, and must be completed within 60 days.
Two ways to move retirement money, and one of them costs the client money for no reason.
Direct rollover
Trustee to trustee. The participant never receives the funds, there is no withholding, and there is no 60-day clock.
This is the answer to almost every rollover question. Where an option describes a direct transfer and another describes taking a check, the direct transfer is correct.
Indirect rollover
The participant receives the funds and has 60 days to deposit them into an eligible account.
From an employer plan, 20 per cent mandatory withholding applies - and to complete a full rollover the participant must make up that 20 per cent from other money, recovering it as a refund the following year.
A USD 100,000 distribution arrives as 80,000 after withholding. To roll the full amount the participant must add 20,000 from elsewhere. If they cannot, that 20,000 is a taxable distribution, plus a penalty if under 59½.
The one-per-year rule
Only one indirect IRA-to-IRA rollover is permitted in any twelve-month period, across all of a taxpayer's IRAs.
It does not apply to direct trustee-to-trustee transfers, of which there is no limit, nor to rollovers from employer plans to IRAs.
Both halves are examinable, and a question describing several transfers in a year is testing whether you noticed which kind they were.
What can roll where
| From | To | Generally permitted |
|---|---|---|
| 401(k) | Traditional IRA | Yes |
| 401(k) | Roth IRA | Yes, taxable as a conversion |
| Traditional IRA | 401(k) | Yes, if the plan accepts |
| Roth 401(k) | Roth IRA | Yes |
| Traditional IRA | Roth IRA | Yes, as a taxable conversion |
| Governmental 457(b) | IRA | Yes, losing the penalty exemption |
| Inherited IRA, non-spouse | Own IRA | No - only a direct transfer to an inherited IRA |
The last row matters. A non-spouse beneficiary who takes possession of an inherited IRA balance cannot put it back, and the whole amount becomes taxable.
Net unrealized appreciation
Where an employer plan holds appreciated employer stock, a lump-sum distribution can move the shares to a taxable account paying ordinary income only on the original cost basis, with the appreciation taxed as long-term capital gain when sold.
Rolling everything into an IRA forfeits that treatment permanently, converting what could have been capital gain into ordinary income. It is a genuine and frequently missed opportunity, and it appears in case studies with a concentrated employer stock position.
Contribution and benefit limits are indexed annually and several were changed by recent legislation. Confirm the current figure against the IRS before relying on it.
Common questions
What is the difference between a direct and indirect rollover?
A direct rollover moves funds trustee to trustee with no withholding and no deadline. An indirect rollover pays the participant, who has 60 days to redeposit, with 20 per cent withholding from an employer plan.
Why is 20 per cent withholding a problem?
The participant receives only 80 per cent and must add the missing 20 per cent from other money to roll the full amount. Otherwise that portion is a taxable distribution, with a penalty if under 59½.
What is the one-per-year rollover rule?
Only one indirect IRA-to-IRA rollover in any twelve-month period across all IRAs. It does not apply to direct trustee-to-trustee transfers or to rollovers from employer plans.
Can a non-spouse beneficiary roll an inherited IRA into their own?
No. Only a direct transfer to a properly titled inherited IRA is permitted. Taking possession of the balance makes the whole amount taxable.
What is net unrealized appreciation?
Where an employer plan holds appreciated employer stock, a lump-sum distribution can tax only the cost basis as ordinary income, with the appreciation taxed as long-term capital gain. Rolling to an IRA forfeits it permanently.